Flexible debt back on book

A HOST of new packaged debt products are hitting the market to take advantage of the tax law changes for superannuation.

Contortionist /File

Flexible debt back on book

A HOST of new packaged debt products are coming on to the market to take advantage of the new tax law changes for superannuation.

The amendments involve the use of instalment warrants by super funds.

Self managed super schemes (SMSFs) can now confidently borrow or gear up with instalment warrants to invest in property and other assets. This is set to open up a whole new range of investment opportunities.

"This is pretty exciting, it's huge really,'' said Justin Frohnert, a certified practicing accountant who specialises in self managed super schemes.

"Using other people's money you can grow your own wealth and your employer can help pay it off with the employer contributions.''

Off limits

Traditionally, debt has been off limits for super schemes but warrants have been a popular strategy for many super funds during recent years - especially equity instalment warrants.

An example are the instalment warrants used to sell T3 Telstra shares to existing Telstra shareholders.

In 2006 the tax commissioner (who is also responsible for regulating SMSFs) and the Australian Prudential Regulation Authority (responsible for regulating other superannuation funds) decided that warrants were a form of debt and therefore not an allowable investment for super funds.

That ban on borrowing by super funds has been in place since the 1980s and is meant to limit risk in retirement savings vehicles.

Now, the Under the Tax Laws Amendment (No. 4) Act 2007, that has all changed. The Act became law on September 23.

The change restores the status quo that existed before the Australian Taxation Office and APRA determined that the instalment warrant structure entailed a borrowing, the government said at the launch of the bill earlier this year.

Now accountants and self-managed super consultants are putting together packages that allow trustees to invest in property, especially in a way that complies with the new rules.

Advantages

There are potentially big tax advantages to investing in property through a super fund compared to a straight property investment in a person's own name outside of super.

Capital gains tax can be minimised and even eliminated if the property is held until the pension phase (age 60). Tax on rental income is 15 per cent maximum and you might effectively receive a tax deduction (via salary sacrifice) for principal loan repayments.

A key element of the rules is that any debt incurred in the investment must be "limited recourse'' and no more than 80 per cent of the purchase price of the investment.

Limited recourse means that if there was a default and recovery action by the lender had to be taken then the maximum amount that can be recovered is the value of the investment.

Unlike a traditional mortgage, where a lender can repossess and sell your house and still demand repayment of any remaining amounts over and above that, a limited recourse loan limits the lender's recovery to the property alone.

Penalties

There are complex rules around this type of investment and big penalties for SMSF trustees that do not comply, so good advice is probably a requirement for people contemplating this type of strategy.

According to SMSF adviser Justin Frohnert, super is becoming a flexible and beneficial investment vehicle.

"The thing I really like about it is, say you like the look of a place at Apollo Bay for example, you can buy it in your super fund, then when you retire you can transfer it to yourself as a lump sum payment.''

Take a balanced approach

How does it work and what are the risks? 

You will need to have a complying self-managed superannuation fund with at least $120,000 total account balance. 

Although there are great tax benefits and an opportunity to leverage into direct property the following risks need to be considered:

Investment risk: While borrowing to invest can magnify returns it can also magnify losses if the investment makes a negative return.
Diversification: An integral part of an investment strategy in superannuation is diversification to minimise risk; having only one investment in super would not comply with this rule.
Loan structure: An ordinary home loan will not be allowed under new rules and as such it is imperative that you seek professional advice from an adviser when structuring your finance within super.
Cash flow: If the property is negatively geared, you need to ensure that the super fund has adequate cash flow to meet interest payments. Apart from the investment property rent a great source of cash inflow are super contributions such as the compulsory 9 per cent employer super contribution.
Legislative risk: Of course, the law can always change to prohibit borrowing in super, but, generally, when super law changes they provide existing investors with some exemptions.
Preservation: Don't forget that you cannot access your superannuation until you meet a condition of release, which for most people is being over 55 and retired.
Super rules: Apart from your commercial property you cannot buy existing property from yourself or your relatives and you cannot live in the property or use it for your own enjoyment, eg. holiday house.

Source: Surrey Partners